At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)
Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
And speaking of the best ...
Love 'em or hate 'em, according to our CAPS stats, Goldman Sachs ranks among the savviest stock pickers on Wall Street. Fortunately, however, you don't have to be a stock market genius to appreciate the wisdom of Goldman's latest call. Upgrading shares of Activision Blizzard (Nasdaq: ATVI) to "buy" on Friday, Goldman made perhaps one of the most obvious statements in investing history when it observed that Activision is really, really cheap.
As Goldman points out, "Activision offers an 11% cash return yield." It boasts "peer high" profit margins of 18%, superior to the operating profit margins of Take-Two (Nasdaq: TTWO) and Sony (NYSE: SNE), at 4% and 9%, respectively. Meanwhile, rivals Electronic Arts (Nasdaq: ERTS) and THQ (Nasdaq: THQI) are losing money. (Albeit Microsoft (Nasdaq: MSFT), also arguably a "peer," earns a whopping 40%.) Activision derives the most income, as a percentage of revenues, from digital games of any of its rivals (Goldman puts this number at "30%+" by looking at free cash flow to sales.)
To top it all off, the company is growing by leaps and bounds, with Goldman projecting 8% annual revenue growth at Activision over the next two years, alongside 20% earnings growth. And with Activision showing "consistent 5%+ annual equity shrink" through share buybacks, Goldman believes we might even see the company post "20%+ EPS growth."
So like I said, Activision is cheap ... right?
Let's go to the tape
Well, not necessarily. It depends on how you look at it. On the surface, at least, Activision is decidedly not cheap. The company currently trades for nearly 34 times earnings, after all. No matter how you slice it, that would be a high price to pay for 20% growth, even with Activision paying a 1.5% dividend to soften the blow.
But here's the thing: You don't get a reputation like Goldman's by accident. And Goldman isn't outperforming the market on better than three out of four of its active software stock picks by chance. Sure, Activision looks expensive on the surface, in the generally accepted accounting principles numbers that (too many) investors focus on. As Goldman Sachs points out, the real story at Activision is written on the cash flow statement, where (too few) investors think to look. Those of us who have thought to look there, however, know that in contrast to the $418 million that Activision reported as its "net income" for 2010, the company actually generated free cash flow closer to $1.3 billion.
Which means that this "34 P/E stock" actually sells for something closer to 10 times free cash flow, or even as low as 7.4 times free cash flow once you net out the company's sizable cash balance -- and folks, that really is "cheap."
Foolish takeaway
Of course, naysayers will point out that Activision has looked similarly attractive for a long time already, even as the stock has flatlined, and shown little inclination of wanting to rise in price. Which is true -- and frustrating for shareholders (as I can attest).
So how long it will take before the rest of Wall Street wakes up and realizes what Goldman has pointed out? I have no idea. All I know is that Goldman is right, and I'm prepared to wait for it to be proven so. Because Activision is cheap, and cheap always wins in the end.
